HSA Rules: Guidelines for Contributing to an HSA

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You can wring big tax breaks from health savings accounts as long as you follow the guidelines set by the IRS. Learn more about these guidelines and what you have to follow to avoid any costly tax penalties.

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A health savings account (HSA) provides tax benefits that can help you reduce your out-of-pocket expenses for health care. Given you and your budget are often faced with higher insurance premiums, co-payments and co-insurance, an HSA is a great tool to help contribute to these costs.

When you save money in an HSA you get three valuable tax breaks. The money you contribute to your HSA reduces your taxable income, the money in your account grows tax-free, and when you withdraw money to pay for a qualified health care expense you will not pay any taxes.

To pocket the tax advantages of an HSA you need to follow the rules laid down by the Internal Revenue Service. Here’s a cheat sheet for how to wring the maximum tax savings from an HSA.

Note: these rules apply only to HSAs. Health reimbursement accounts (HRAs) and flexible spending accounts (FSAs) are covered by separate IRS regulations.

HSA Eligibility

Health savings accounts complement your health care insurance. That being said, not everyone who has health insurance coverage is allowed to have an HSA. You must be enrolled in a high-deductible-health plan (HDHP) to be eligible to contribute to a health savings account.

If you are covered by someone else’s health care plan that is not an HDHP, or you are claimed as a dependent on someone else’s income tax return you are not eligible to contribute to an HSA.

It gets even trickier, as the IRS has some hoops an HDHP must jump through that determines if enrollees will be allowed to have an HSA.

The Internal Revenue Service sets the annual minimum deductible that must be charged for an HDHP to be “HSA eligible” every year. These amounts are adjusted annually to keep pace with inflation. In 2020, a high-deductible plan must charge a deductible of at least $1,400 for individual coverage and $2,800 for family coverage for enrollees to be eligible to also have an HSA.

The IRS also insists that a high deductible plan that is linked to an HSA must have a cap on the annual out-of-pocket costs an enroll will be required to pay. In 2020, the maximum annual out of pocket limit for a HDHP that is HSA-eligible is $6,900 for individual coverage and $13,800 for family coverage.

Annual Limits on What You Can Save in an HSA

If you are eligible to save in an HSA, there are annual contribution limits. In 2020 an individual can make an HSA contribution of $3,550 and the limit for family coverage is $7,100. If you are at least 55 years old by the end of the year you can add another $1,000 “catch-up” contribution. Your HSA contribution limits include any money your employer contributes to your account.

NOTE: Not all employers contribute to employee HSAs. If you’re considering changing health plans, ask your employer if they have any contribution benefits to offer for HSAs.

If your HSA is part of your workplace benefits, your HSA contribution will be deducted from your paycheck before taxes, effectively reducing your taxable income for the year. For instance, if your salary is $100,000 and you contribute $7,100 to an HSA in 2020, your taxable income for the year will only be $92,900.

If you are funding an HSA from your after-tax income, you will also snag a tax break. When you file your federal taxes, your HSA contributions can be deducted from your gross income. You can claim this deduction even if you opt to claim the standard deduction on your federal tax return.

HSA Savings and Investing options

One of the major benefits of an HSA is that you are completely in charge of your HSA account. You can choose to keep your money in a safe FDIC-insured bank account or choose different invest through options, such as mutual funds, exchange-traded funds (ETFs), and stock and bonds through a financial institution. You owe no taxes on money while it remains in your savings or investment account.

There is no use-it-or-lose-it requirement. The money in your HSA account rolls over year-to-year and keeps growing tax-deferred. An HSA can be a tax-smart way to build retirement savings that you can then tap tax-free in retirement to pay for qualified medical expenses.

Expenses That Can Be Paid with Tax-Free Dollars

You can withdraw money tax-free from your HSA if it will be used to pay for something that the IRS deems to be a “qualified medical expense.”

The laundry list of eligible expenses includes co-payments, co-insurance, Medicare premiums, dental expenses and regular dental care, vision care, prescription drugs, hearing aids, and long-term care premiums. IRS Publication 502 gives a run-down of all the qualified medical expenses that can be paid for with tax-free dollars from an HSA account.

A short-list of non-eligible expenses that don’t qualify for tax-free withdrawals: health insurance premiums, cosmetic surgery, health club dues and over-the-counter medications.

To view a more detailed list of eligible items, visit our HSA Eligibility List.

It’s typically best to keep your withdrawals focused on eligible expenses. When you use HSA money to pay for health care expenses that aren’t on the “qualified” list you will owe income tax on the amount withdrawn, and if you are younger than 65 you will also be hit with a 20 percent penalty.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.